CPH Chapter 5: Client Discovery & Account Opening PDF

Client Discovery and Account Opening 5 CHAPTER OVERVIEW In this chapter, we discuss client discovery and all aspects of the account opening process, including the ongoing procedures for maintaining accurate records. LEARNING OBJECTIVES CONTENT AREAS 1 | Explain the procedures for opening accounts, Opening Accounts including anti-money laundering. 2 | Recognize the importance of the account The Account Application application. 3 | Describe what constitutes the proper Completing the Account Application completion of the account application. 4 | Understand account disclosure requirements, Disclosures including the Relationship Disclosure Document. 5 | Identify the procedures for maintaining client Client Records records. © CANADIAN SECURITIES INSTITUTE 5 2 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 KEY TERMS Key terms are defined in the Glossary and appear in bold text when they first occur in the chapter. beneficial owner margin account cash account politically exposed person client discovery power of attorney delivery against payment The Proceeds of Crime (Money Laundering) and Terrorist Financing Act discretionary account red flag insider registered account managed account © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 3 INTRODUCTION The opening of a new account is an important first step in your relationship with your clients. It gives both you and your client an opportunity to review all aspects of the client’s situation. Only with that information will you able to make appropriate investment recommendations. This period, during which you and your client ask questions and get to know each other, is known as client discovery. Sometimes an existing client will open an additional account, which provides an opportunity to review the client’s situation and amend his or her account documentation, if necessary. For you, as a Registered Representative (RR), it is one of the most important opportunities to evaluate and document a particular client’s background. The information you gather at this stage forms the basis of all your future recommendations. Every interaction you have with your clients is an opportunity to get to know them better. The knowledge you gain in this chapter will help you to demonstrate your understanding of each client’s situation by making recommendations that suit their particular objectives and constraints. OPENING ACCOUNTS 1 | Explain the procedures for opening accounts, including anti-money laundering. As an RR in the investment industry, you are responsible to both the client and the dealer member for whom you are employed (given that your employer is also the sponsor of your licence). As such, you must accept, understand, and display high standards of integrity in your conduct. The standards of conduct discussed in this section provide a framework for responsible dealings with clients. It begins with a brief review of your duties when placing orders. THE CARDINAL RULE: KNOW YOUR CLIENT As an RR, you must always keep in mind that your clients’ interests are paramount. To this end, you must constantly update all client information to ensure that your recommendations are always appropriate based on current client information. It is your duty under the Know Your Client (KYC) rule to give cautionary advice if a client places an order that appears unsuitable based on their client account documentation. You must also ensure that the recorded objectives and risk factors continue to be suitable for the particular client. If there are any significant changes in a client’s circumstances, that client’s suitability information must be updated. The KYC rule is the cornerstone of all your dealings with clients. It represents an obligation that begins during the client intake process and carries on throughout the client relationship. The KYC rule requires that every dealer member take reasonable steps to learn and remain informed of essential facts relative to every order, account, and client it accepts. Compliance with the rule ensures that the firm has collected sufficient information about the client’s personal and financial circumstances, investment needs and objectives, investment knowledge, risk profile, and investment time horizon. This information is necessary to make a suitability determination for the retail client in a way that puts the client’s interest first. As previously stated, suitability must also be considered in light of the concentration and liquidity of securities within the account, the potential and actual impact of costs on the retail client’s returns, and a reasonable range of alternative actions available to the advisor at the time suitability is determined. You should consider the following variables about your clients to determine whether a proposed trade is suitable: Age, marital status, and occupation Income and net worth Number of dependents Risk profile © CANADIAN SECURITIES INSTITUTE 5 4 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 Investment objectives Investment knowledge and experience Investment time horizon The account’s current investment portfolio composition, duration, and risk level A client’s age and life stage are critical components of an investor’s KYC proﬁle. Your ﬁrm cannot meet its regulatory obligations without considering these factors. One of the most effective ways to ensure compliance with the KYC obligation is by hiring skilled and knowledgeable advisors. Those advisors must apply a robust initial KYC process followed by regular revisits with their clients to update their KYC information and review the related advice and strategies. Follow-ups are particularly important when dealing with senior investors. OBTAINING INFORMATION AT THE ACCOUNT OPENING STAGE RRs are required to obtain sufﬁcient information about their clients to ensure that recommendations are appropriate for each investor, and that their clients’ accounts are managed in a way that is consistent with their investment objectives. Some RRs use the account opening process to ask questions that may broaden the conversation with investors. As an RR, you may use the following techniques during this process: Document your client’s response to lifestyle questions such as: When do you plan to retire? How much money do you need to retire in the fashion you want? Do you have any other issues or expenses that we should contemplate as you retire? Do you have children or grandchildren who are dependent on you ﬁnancially? Do you have a will and a ﬁnancial power of attorney? Require in-person meetings with your clients to ﬁll out the account application. This step helps to ensure that all investor information on the account application is accurate and up to date. Encourage the client to bring a trusted family member or friend to meetings. Require frequent updates of new account information, such as on an annual basis. These steps help to ensure that both you and your firm have the information you need about clients at the account opening stage to determine whether particular investments are appropriate. CLIENT IDENTIFICATION REQUIREMENTS: ANTI-MONEY LAUNDERING As an RR, you also play an important role in combating and detecting money laundering and terrorist financing activities. The same is true for all employees who have direct contact with clients, as well as those who monitor and supervise daily activities. Any employee who does not diligently fulfill his or her reporting responsibilities under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) can potentially face either or both a prison term of up to five years and a fine of up to $2,000,000. Anti-money laundering and anti-terrorist financing (AML/ATF) procedures are typically incorporated into the existing KYC obligations as described in current rules and regulations. The Canadian Investment Regulatory Organization (CIRO) sets out the rules for account opening procedures, requiring that, for each account opened, a dealer member must obtain and maintain certain customer information. Similarly, procedures should emphasize that dealer members must request the essential facts relating to each customer and each account. Account opening procedures should provide the information necessary to make a reasonable, risk-based assessment of clients, their source of income, and the amount of expected activity in an account. This knowledge will help you determine what extra customer information and documentation is needed for certain clients. It also helps to determine whether a particular account, such as an offshore account, requires additional monitoring and due diligence. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 5 During the client discovery process, as well as throughout the client relationship, as the RR, you and other registered staff are in the best position to observe and evaluate client behaviour from a money laundering perspective. It is in monitoring such behaviour that you may observe the red flags that may indicate money laundering or terrorist financing activities. Red flags are warning signals of possible improper activities that, after being reported, can provide an appropriate basis for further actions. Thus, the client discovery process and ongoing client interactions are of critical importance, not only to the KYC obligation, but also to the prevention of illegal activities. The process of client identification and verification on its own is not sufficient. You must also exercise professional judgment and seek help where necessary, both in opening accounts and in subsequent dealings with clients. Simply having followed the letter of the regulations may not be enough if there are red flags suggesting that clients may be involved in money laundering or that their transactions are suspicious. ACCOUNT OPENING RED FLAGS One of the most effective tools a dealer member can implement to assist employees in performing their duties relating to AML/ ATF provisions is an effective red flag program. A red flag should raise suspicion that there is a reasonable chance a transaction is related to a money laundering offence or terrorist financing activity. Any of the following client activities or behaviours may raise red flags during the account opening process: Reluctance to provide adequate information or supporting documentation Documentation that appears to be altered or counterfeit, or if all of the documents have recent issue dates Documents that are photocopies, facsimile images, or other electronic reproductions, even when certified as true copies by an attorney acting on the client’s behalf Attempts to open accounts in other people’s names Supplying information that seems vague or even potentially untrue Providing an address that is out of the local service area Providing a post office box, general delivery, or other type of mail drop address, when a street address is the norm for that area Providing a phone number where the client cannot be reached Making inquiries that suggest a desire to avoid reporting Reluctance to complete or supply required documentation Inquisitiveness about compliance and anti-money laundering procedures Attempts to use aliases or open accounts in different names GENERAL ANTI-MONEY LAUNDERING DUE DILIGENCE Anti-money laundering procedures must be established on the basis of the risk that particular types of clients may be involved in money laundering. For example, firm policies must impose the following requirements: Use extra due diligence with clients from bank secrecy jurisdictions or countries with high levels of corruption. Provide extra information and documentation about corporations and trusts, particularly private offshore entities. Pay particularly close attention to the following clients: Clients who deal with cash businesses Clients or their close associates who are in a prominent position of public trust Clients who have had suspicious transactions filled in their accounts © CANADIAN SECURITIES INSTITUTE 5 6 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 DID YOU KNOW? Certain clients in a prominent position of public trust, their immediate family members, and their close associates are referred to as politically exposed persons (PEPs). Foreign PEP accounts are generally a bigger concern from a money laundering perspective than domestic PEP accounts. The foreign PEP category includes the following persons: Any person who holds, or has held, an office or position in, or on behalf of, a foreign state That person’s spouse, common-law partner, child, mother, father, brother, or sister The spouse’s or common-law partner’s mother or father Note that the definition of a foreign PEP covers only those holding such positions in a national state, not those holding offices in provinces or municipalities. An account for a foreign PEP must be approved by senior management within 30 days of opening and be subject to enhanced ongoing monitoring. Accounts for domestic PEPs must also be assessed for risk of money laundering. If the risk is deemed high, then the accounts are subject to the same controls as foreign PEPs. Anti-money laundering regulations require that dealer members verify the identity and date of birth of any person opening a securities account. This information must be established before any transactions, other than an initial deposit, are conducted. With limited exceptions, the identity of all persons authorized to give instructions on an account must be verified. This requirement applies not only to accounts of individuals, but also to those of corporations and other entities (i.e., accounts with third-party authority). CIRO’s client identification requirements refer to the overall client profile, including KYC and suitability obligations. They are not specific to the identity documents used to verify a client exclusively for the purposes of the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC). There is no expectation to repeat the client identity verification process, unless there is some doubt as to the client’s identity or the validity of documents previously viewed. ACCOUNT UPDATES AND REVIEWS Your dealer member’s compliance regime should include procedures to ensure that any accounts considered higher risk for money laundering are reviewed regularly to assess whether there have been any significant changes to a client’s profile. Non-individual accounts should include regular reviews to detect significant changes to the ownership structure. A dealer member’s AML/ATF regime should include a program of risk rating, whereby all client accounts are categorized according to risk. On this basis, the firm should evaluate and supervise the different categories of accounts. In other words, high-risk accounts should have a more stringent supervisory system in place, given their categorization. Accounts in the high-risk category may include, for example, offshore accounts, all PEP accounts, and all accounts for which a suspicious transaction has been filled. It is up to the dealer member to evaluate the additional supervisory protocols that may be needed to ensure that these accounts are not at risk for money laundering activities. You are expected to update each client’s profile and investment objectives whenever there is a significant change to a client’s situation. Likewise, any unusual activity that indicates possible money laundering activity should result in an update to the client’s documentation. Examples of such activity may include an increase in account assets beyond the apparent means of the client or an unusual pattern of transfers or deposits. Regarding periodic reviews, FINTRAC guidelines suggest regular intervals of two years. There is no mandated change to the existing expectation to update whenever there is a significant change. However, more frequent updates may be necessary on higher-risk accounts where transaction monitoring has triggered concerns. Enhanced and ongoing monitoring of high-risk accounts should be a routine part of the dealer member’s AML/ATF compliance regime. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 7 A periodic review does not mean that all client profiles must be updated; rather, you should review accounts initially to determine which ones warrant updates. The profiles of many clients are likely to remain materially unchanged, and others with whom you have regular contact should already be up to date. For an individual’s account, you must retain new account applications, confirmations of purchase or sale, guarantees, trade authorizations, powers of attorney, joint account agreements, and all correspondence about the account’s operation. In addition, you must retain a copy of every statement sent to clients. ANTI-MONEY LAUNDERING PROCEDURES FOR CORPORATE ACCOUNTS Under the PCMLTFA, when opening an account for a private corporation, trust, or similar entity, you must gather specific information about both the entity and the beneficial owners behind the entity. Beneficial owners of a trust are the trustees and known beneficiaries and settlors of the trust. Beneficial owners of a corporation or an entity other than a corporation or trust, such as a partnership, are individuals who own or control 25% or more of the entity, either directly or indirectly. As an RR working on the dealer member’s behalf, you must record the information obtained. If you cannot obtain the information, you must record the reason why. Furthermore, if the information cannot be obtained within 30 days of the account’s opening, your firm must restrict the account to liquidating trades and transferring assets out until the information has been obtained. ANTI-MONEY LAUNDERING PROCEDURES FOR NON-RESIDENT ACCOUNTS Non-resident individual accounts have additional identity verification requirements than those set out for resident individual accounts. Dealer members must also be familiar with the registration requirements of the countries in which they intend to conduct business. The dealer member must determine these requirements before any business is solicited in other countries, especially if solicitation efforts are conducted in that country. In addition to registration requirements that may exist in foreign jurisdictions, dealer members should evaluate whether the foreign jurisdiction in question is subject to any money laundering concerns or any outright sanctions imposed by the United Nations. These issues may preclude or significantly dissuade the firm from dealing with residents of these countries. Furthermore, when dealing with offshore clients, procedures should be in place that allow the dealer member to identify PEP accounts. When opening accounts for a personal holding company or personal investment corporation, you must determine whether the account is being set up by, or for the benefit of, a PEP. These procedures protect you and your dealer members from unknowingly dealing with the proceeds of embezzlement or foreign corruption. IMPORTANT NOTE When dealing with offshore accounts, you must be wary of any offshore client who is unwilling or unable to clearly and accurately provide detailed ownership information. A local resident opening an account for an offshore entity should also give rise to suspicion. You should enquire as to the ownership and nature of the entity’s business, as well as the nature of the relationship between the resident and the entity. Also, consider that your registration may not allow you to provide services to clients living in an offshore jurisdiction or in the particular jurisdiction in question. ANTI-MONEY LAUNDERING PROCEDURES FOR INSTITUTIONAL ACCOUNTS Dealer members are also required to have AML/ATF procedures in place to cover their institutional business and clients. These accounts are characterized as being opened and operated for customers who are usually financially sophisticated and often purchase and sell securities in significant volumes. Institutional clients themselves are usually widely known, regulated, and publicly held. © CANADIAN SECURITIES INSTITUTE 5 8 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 Due to the nature of institutional business practices, dealer members may actually have little or no direct contact with the underlying beneficiaries of their institutional clients. Instead, they deal solely through intermediaries. Two typical examples of intermediaries in this type of relationship are investment funds and hedge funds. In other cases, however, institutional accounts are established solely for trade execution purposes. In such cases, there is a very limited relationship between the institutional client and the dealer member itself. CIRO rules clearly state that dealer members dealing with institutional accounts must have supervisory reviews that are designed to detect transactions that raise suspicion of money laundering or terrorist financing activity. In addition, the rules require that all dealer members use due diligence to learn and remain informed of the essential facts relative to every client and to every order or account accepted. The dealer member should determine to what extent an institution or intermediary has the authority to act on behalf of underlying clients. Where appropriate, it should also determine whether the institutional client or intermediary has policies and procedures to know its own clients. Under the PCMLTFA, dealer members are exempt from identity and verification requirements for certain types of Canadian institutions and intermediaries that are, themselves, subject to the regulations. However, similar foreign institutions and intermediaries are not exempt. PERSONAL IDENTITY DOCUMENTS Dealer members must also develop policies regarding the use of the internet for account opening. Such use is becoming more prevalent, as is the use of electronic signatures on account applications. Identity verification requirements set by the PCMLTFA apply regardless of the method used to open the account. Therefore, you must still review the original copies of personal identification documents (e.g., photo identification issued by a government, such as a driver’s licence or passport) when opening an account to verify the account holder’s identity. Photocopies, scanned copies, or other reproductions are not acceptable for verification purposes. THE ACCOUNT APPLICATION 2 | Recognize the importance of the account application. Before opening a new account, you and your client must complete an account application, either on paper or electronically. The account application is a critically important document and represents, in most instances, the beginning of the client relationship with you and your dealer member. The account application is the contract for services between the dealer member and the client. In most cases, it is executed by the RR on behalf of the dealer member, and it must include the following items noted below: The client’s identity, including his or her full name, address, citizenship, and social insurance number Personal information, such as the client’s marital status, number of dependents, and employment Personal financial information, including the client’s income, net worth, and liquidity The client’s investment objectives, risk profile, and level of knowledge about investing Information about the client’s relationship with any publicly traded companies (i.e., insider status) The account application also has fields that allow you to make notes or comments about the client. You can use this space to specify material issues that may be relevant to the account opening. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 9 In addition to completing the account application, you should maintain the notes you took during the client discovery process, as well as any other documentation completed, such as a discovery questionnaire. When you have completed, reviewed, and signed the form, it must be approved by the Designated Supervisor. In addition to forming the basis for the legal relationship between the dealer member and the client, the account application is used for four main purposes, as follows: To establish the identity of the client To collect sufficient information to meet suitability obligations, such as the client’s investment objectives To judge the client’s creditworthiness To determine whether the client is an insider of a reporting issuer or other publicly traded company Exhibit 5.1 shows a sample account application. The information on this form demonstrates the minimum requirements for a new account. Your dealer member may require additional information. A copy of the information on an application must be made available to all persons who are responsible for the supervision of that account. Responsible parties, besides yourself, include your supervisor and staff in the head office, such as a sales manager or compliance officer. © CANADIAN SECURITIES INSTITUTE 5 10 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 Exhibit 5.1 | Account Application ACCOUNT APPLICATION ACCOUNT SUPERVISION (to be completed by Registered Representative) OFFICE ACCOUNT R.R. (1) (a) Name Mr. Mrs. Miss........................................................................................................................................................................ Phones: Home........................................................................................... Please Print Home address............................................................................................................................................................................ Business...................................................................................................... Street................................................................................................................................................................................ Other...................................................................................................... City Province Postal Code................................................................................................................................................................................ Fax...................................................................................................... Date of Birth................................................................. Social Insurance Number........................................................... Citizenship..................................................................................................... Type of Account Requested : (b) Is RR registered in the Province or Yes.................. Cash.................................................................. RRSP/RRIF.............................................. U.S. Funds.................................... Country in which the client resides? No.................. Margin............................................................... Other....................................................... D.A.P.................................................................. Pro............................................................ CDN Funds................................. (2) Clients Name................................................................................................................................ Type of Business................................................................................................................................... Employer: Address............................................................................................................................ Client’s Occupation............................................................................................................................. (3) INVESTMENT KNOWLEDGE Sophisticated............................ EST. NET LIQUID ASSETS Good............................ (Cash and securities less loans Limited............................ outstanding against securities) A.................................................................. Poor/Nil............................ PLUS ACCOUNT OBJECTIVES ACCOUNT RISK FACTORS......... EST. NET FIXED ASSETS B.................................................................. Safety.................. % Low................... % (Fixed assets less liabilities EQUALS Income Medium................... % outstanding against fixed assets) Capital Gains.................. % High................... % EST. TOTAL NET WORTH (A + B = C) C.................................................................. Short Term.................. % 100 % APPROXIMATE ANNUAL INCOME FROM ALL Medium Term.................. % SOURCES D.................................................................. 100 % (4) Spousal & Family Information: Marital Status:........................................................................................................................................... Occupation: Spouse’s Name........................................................................................................................................... Number of Dependents:.................................................................................................................... Spouse’s Employer........................................................................................................................................... Type of Business........................................................................................................................................... (5) How long have you known client?..................................................................... Advertising Lead...................... Phone In........................................ Have you met the client face to face? Personal Contact..................... Walk In.......................................... Yes..................... No..................... Referral by:.....................................................................................................................................(name) (if customer, give account no.)................................................................................................................... (6) If yes for Questions 1, 2, or 3, provide details in (10). 1. Will any other persons or persons : (a) Have trading authorization in this account? Yes................ No............... (b) Guarantee this account? Yes................ No............... (c) Have a financial interest in such accounts? Yes................ No............... 2. Do any of the signatories have any other accounts or control the trading in such accounts? Yes................ No............... 3. Does client have accounts with other Brokerage firms? (Type: ) Yes................ No............... 4. Is this account (a) discretionary or (b) managed (a)................ (b)............... Insider Information 5. Is client a senior officer or director of a company whose shares are traded on an exchange or in the OTC market? Yes................ No............... 6. Does the client, as an individual or as part of a group, hold or control such a company ( ) Yes................ No............... (7) (a) General Documents Attached Obtaining (b) Trading Authorization Documents: Attached Obtaining – Client’s Agreement................................... – For an individual’s Account................................................. – Margin Agreement................................... – For a Corporation, Partnership, Trust, etc.................................................. – Cash Agreement................................... – Discretionary Authority................................................. – Guarantee................................... – Managed Account Agreement................................................. – Other................................... (8) Bank Reference : Name.......................................................................................................... Branch Number........................................................................................ Account Number..................................................................................... (9) Deposit and/or Security received............................................................................................................. Initial................................................... Buy......................................................... Solicited................................................ Amount................................................................................................................ Order................................................. Sell.......................................................... Unsolicited.......................................... Description.......................................................................................................... (10) RR Signature.................................................................................................................................................. Branch Supervisor Signature............................................................................................................... Date................................................................................................................................................................ Comments:.............................................................................................................................................................................................................................................................................................................................. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 11 In addition to completing an account application for all new clients, you should update existing account applications regularly and whenever a significant change occurs in a client’s circumstances. The following examples of a significant change should trigger an update to a client’s account application: Change of account name (e.g., from Marie Roy to Marie and Robert Roy) A change of the client’s address out of your jurisdiction New marital or employment status Another person taking a financial interest in or gaining control over the account New trading authorization A major change in financial circumstances New investment objectives or risk factors An amendment to any item in the regulatory section (i.e., insider status) Any significant change in circumstances could affect the client’s investment objectives, creditworthiness, or risk profile. From a legal perspective, to update account documentation is to amend it and then re-sign it. There is no strict rule in terms of how often you should take these formal steps. However, you should routinely have discussions with your clients—and document those discussions—to evaluate whether the account application should be formally updated. At a minimum, this requirement includes annual discussions to re-confirm that the information contained on the account application is still accurate. Dealer members often send out annual confirmation letters requesting that clients review their current investment objectives and advise the dealer member of any changes. If a client fails to respond, the dealer member assumes that the account application as presently completed continues to be accurate. Reviews of (and possible updates to) the account application may also be required between regular updates; they are not always associated with major changes in the client’s circumstances. Dealer members must also review a retail client’s account and the securities in that account for suitability and take reasonable steps within a reasonable time after any of the following events occur: Securities are received or delivered into the client’s account. A registered individual is designated as responsible for the client’s account. The dealer member or a registered individual becomes aware of a change in a security in the account or in the client’s KYC information that could result in unsuitability of a security or the account. The dealer member or a registered individual has undertaken a review of the client’s KYC information. These suitability reviews do not necessarily result in the account application being formally updated. Nevertheless, they are excellent opportunities for you to have enhanced discussions with your clients. Documentation of those discussions can lend support if you must demonstrate that you know your client. © CANADIAN SECURITIES INSTITUTE 5 12 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 Case Study | Jane Jane is an RR at ABC Financial Inc. The account application for one of Jane’s clients, Bruno, indicates that he has a moderate income, a moderate net worth, and conservative investment objectives. Bruno calls Jane to tell her he has recently come into a substantial inheritance. Based on his new net worth, Jane recommends that he purchase several growth and speculative stocks valued at more than $200,000. When Leona, Jane’s supervisor, sees these orders the next day, she checks the client’s account application. It shows a net worth of $100,000, an annual income of $50,000, and objectives of 50% income and 50% safety. Concerned, Leona calls Jane into her office and asks her to explain how the client can pay for these securities and whether they are appropriate for him. Discussion In this example, Leona noticed that Bruno’s client documentation did not show sufficient financial resources or risk profile to support the acceptance of his orders. Either the orders were well beyond his apparent ability to pay, or he had experienced a major change in his financial situation that had not been recorded. It is not clear in this case whether Jane discussed any possible changes in Bruno’s objectives. She should have had this discussion to determine whether his current objectives are still applicable, or whether they have changed in light of his changed financial circumstances. In that discussion, she should have taken into account Bruno’s age, occupation, plans for retirement, and risk profile. She should then have updated the account application to reflect the change in Bruno’s circumstances and attitude, and also to justify the suitability of the recent purchases in his account. It is not always enough to simply know your client; you must also be able to demonstrate your knowledge of the client. Suppose, for example, a client’s investment does not perform well, and the client complains. Without proper documentation to back you up, you would have a hard time justifying the order. If the complainant claims to be an unsophisticated and conservative investor, and has the investment history to support these claims, a regulator might sanction you for giving unsuitable advice. COMPLETING THE ACCOUNT APPLICATION 3 | Describe what constitutes the proper completion of the account application. There are three general categories of information required on the account application, as follows: Client information Account information Registrant information The three categories are discussed in detail below. CLIENT INFORMATION Client information includes such basic identifying information as the client’s name, address, and marital status. It also includes basic financial information, including the client’s total net worth, level of investment knowledge, investment objectives, and risk profile. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 13 CLIENT NAME It is important to open an account in the correct legal name of the client and not in an abbreviated form. For example, “David Edward Smith” should not be abbreviated to “Dave Smith”. The full and correct legal name provides an additional level of defence against possible deception, such as forgery. It also helps to prevent “false positives” in data analysis from an AML/ATF perspective. Particular care must be taken where the client is an entity and not a person. For example, if a company’s legal name is Acme Widgets Incorporated, you should not abbreviate it to Acme Widgets Inc. or Acme Widgets. In the latter case, for example, the fact that Acme Widgets is a limited liability company is no longer apparent. An incorrect or incomplete name may have serious legal repercussions if an account’s ownership is in question. CONFIDENTIAL, NOMINEE, OR NUMBERED ACCOUNTS Dealer members are allowed to maintain accounts for clients identified only by number, nominee name, or other symbol. This is permissible in order for clients to maintain confidentiality. The dealer member must keep, at its principal office in Canada, sufficient identification in writing to establish the beneficial owner of the account or the party or parties financially responsible for the account. This information must be available at all times at the request of the applicable regulators. HOME ADDRESS You should obtain both a residence address and a business address. At least one of these must be a permanent address, and not a post office box or other such temporary address. The address is obtained to comply with AML/ATF and securities regulations and also to ensure that the RR is registered in the province where the client resides. Additionally, because the dealer is required to mail trade confirmations and account statements to clients, it must have an address on file. If it is not possible to obtain a permanent address, you should proceed with caution. Some clients may have a valid reason why they do not have a permanent address. However, it may be an indication that the prospective client is trying to circumvent industry rules or avoid making a payment. In any questionable case, you should bring the matter to the attention of the sales supervisor, compliance department, or whomever is responsible for enforcing policy in this regard. Under no circumstances may you use your residence, post office box, or other address for client mail. This prohibition includes the postal direction, “c/o the RR” at the office. It is a serious conflict of interest to act in any way as an intermediary in the mailing of trade confirmations, dealer statements, or other communications to a client. MAIL CONFIRMATIONS A client may ask that mail confirmations be mailed to an address other than the one given as the home address. It is very important that clients receive confirmations. You must therefore make sure that the client’s home address is real and valid and that the mailing address is not false or a mailbox. CONTACT NUMBER(S) In addition to home and business numbers, many people have cell phones, cottage phones, etc. It is a good idea to gather as much information as possible so that the client can be contacted if circumstances require immediate communication. If the client is a new acquaintance, residence and business numbers should be verified. SOCIAL INSURANCE NUMBER A social insurance number is required for tax reporting. If a client claims not to have one or refuses to disclose it, you should consult your branch supervisor or the new accounts department. © CANADIAN SECURITIES INSTITUTE 5 14 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 DATE OF BIRTH The client’s birth date, rather than age, is required. The date of birth is essential for registered accounts, such as registered retirement savings plans and income funds (RRSPs and RRIFs), to prevent serious consequences regarding deregistration. In these cases, the calendar year of the client’s birth must be recorded. Special care must be taken when dealing with elderly clients and minors. DID YOU KNOW? Encouraging Investors of All Ages to Prepare for the Future: During the account opening process, you should encourage your clients to take steps to plan for the event of mental or physical incapacity. Dealer members are required to take reasonable steps to obtain from the client the name and contact information of a trusted contact person, and written consent to contact that person under certain circumstances. For example, it may be the policy that you can call the person if you are unable to reach the client or if you suspect diminished capacity or elder abuse. The firm may receive permission from the client to keep this information in his or her ﬁles. You should also ask your clients whether they have provided a power of attorney granting authority over their accounts, under certain circumstances, to a trusted friend or family member. The following practices are useful in encouraging clients to make arrangements that facilitate the ease of account management in a crisis: Discuss the beneﬁts of executing powers of attorney with all clients as a matter of routine during the account opening process. Inquire prior to opening an account whether anyone else should be consulted with regard to the account. OPENING ACCOUNTS IN THE NAME OF MINORS You should avoid opening accounts in the name of minors because contracts made by minors may be repudiated within a reasonable time after reaching the age of majority. Furthermore, minors are subject to the following restrictions: They cannot exercise their right to vote if they own voting shares. They do not have the capacity to designate beneficiaries with respect to RRSP accounts. They cannot make RRSP contributions if they have not earned income and filed taxes in the previous year. If asked to open an account for a minor by an established client, you should check with the new accounts department or compliance department to determine what special documentation is required, such as a personal guarantee from a parent or legal guardian. These persons can also advise you as to the age of majority in different jurisdictions. Your firm’s policies and procedures manual is another resource in this regard. Note that the Quebec Civil Code contains a special status of emancipated minor for persons under 18 who, by marriage or court order, are emancipated to perform certain acts, including securities trading, as if they had attained the age of majority. Emancipated minors may have their contractual obligations reduced if a court determines them to be excessive—i.e., not strictly necessary as a prudent course of investment action. CITIZENSHIP Only Canadian citizens resident in Canada can purchase certain percentages or numbers of shares of companies that are considered culturally or economically important to Canada. Such companies, known as constrained share companies, include, for example, broadcasting companies and banks. It is therefore important to know a client’s citizenship in case orders are placed for shares of such companies. In many instances, these companies require purchasers to complete an Ownership Declaration, thereby providing a formal statement confirming citizenship and residency. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 15 Non-resident individual accounts require additional identity verification beyond what is required for resident individual accounts. A current passport number or other valid government identification will typically suffice. Confidential accounts are sometimes permitted for certain clients, such as celebrities, undercover police officers, and politicians. If your dealer member permits such accounts, you must obtain appropriate documentation to be kept on file identifying the underlying owners. A client’s citizenship information is also important for tax reporting purposes. EMPLOYMENT Employment information is required for three reasons: To help establish the client’s creditworthiness To establish whether any regulatory issues apply to this account, such the requirement to report insider status To evaluate the client’s ability to withstand losses, and, thus, whether specific investment objectives are warranted With clients who are self-employed, you should pay particular attention to their financial information to assist in checking credit. MARITAL STATUS A client’s marital status has both a financial and legal impact on an account. It is therefore necessary to obtain certain information about a married client’s spouse or equivalent to spouse. (The definition of a spouse equivalent varies depending on the applicable legislation.) Information regarding marital status serves three purposes: It helps to determine the creditworthiness of the client. It ensures that investment objectives and risk factors are determined relative to the client’s overall circumstances. It helps to determine whether the spouse is subject to any regulatory requirements by virtue of his or her employment (i.e., insider status). Where a spouse or family member guarantees the account of another, you should make a diligent effort to confirm that the guarantor (i.e., the person guaranteeing the account) understands the obligation being assumed. You should explain what impact the type of trading activity in the account will have on his or her potential liability. For example, a speculative margin account is of greater risk to the guarantor (and the account owner) than an account made up primarily of preferred stocks and government bonds. Where you feel that the guarantor does not understand his or her obligations, the registrant should consult with the supervisor to determine the proper course of action. FINANCIAL INFORMATION Financial information is fundamental in judging a client’s creditworthiness if credit is to be extended. It is also a major factor when establishing the suitability of investment recommendations. Financial information includes total net worth and annual income. Total net worth is the sum of all assets (liquid and fixed) less all liabilities (secured and unsecured). Fixed assets typically include real estate and business assets. Liquid assets include assets that can readily be turned into cash, even if they are invested in registered or non-registered accounts. These liquid assets are the assets that are likely to be available for investment. When stating assets, it is important to be clear as to what amount is owned. For example, if a couple holds individual accounts, they should not both include the total equity in the matrimonial home as an individual fixed asset. © CANADIAN SECURITIES INSTITUTE 5 16 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 In the annual income category, only one combined figure is required. However, you would be wise to inquire as to whether that figure is composed of employment income, investment income, or income from other sources. Dealer members are required to know their clients and to monitor account activity for unusual transactions, actual or attempted. Therefore, as the RR, you must have a good understanding of the source of your clients’ overall net worth and any significant changes to that figure. This knowledge is necessary, not only to meet AML/ATF requirements, but also to ensure that your advice meets your KYC and suitability obligations. In cases of higher AML/ATF risk, or where there is an apparent discrepancy between a client’s life circumstances and their means, it is appropriate to ask for more detailed information. For example, for AML/ATF purposes, you should determine the source of funds for a client with a low-paying occupation but significant net worth. This information should also influence any recommendations you make based on such suitability factors as the client’s ability to sustain losses. INVESTMENT KNOWLEDGE Discussions with your clients will disclose their knowledge of investment matters and the amount of guidance that would be most beneficial. The use of tools in this regard helps to ensure that a consistent process is used for all clients. In most cases, it is appropriate to help clients determine their level of investment knowledge. For example, if a client says his knowledge is excellent, you should ask questions to ensure this is the case. Experience is an important component of investment knowledge. Consider two clients who appear to be equally knowledgeable about investing. The first client has only ever held guaranteed investment certificates in his account, whereas the second is heavily invested in equities. In this case, the second client should score higher in investment knowledge. Furthermore, when clients remain with you for an extended period of time, it might make sense to increase their score. As they review quarterly statements, attend education seminars, and meet with you to discuss their investments, their level of knowledge will likely increase. If you do not update their account application to reflect their participation, it may appear as though they are not reviewing their statements or understanding the discussions held during review meetings. You should also consider that certain attributes may not make sense in the context of the account application as a whole. For example, a client who specifies a very low investment knowledge (or a very short timeline) may not be eligible for an investment objective that is high risk. Following the completion of the account application, you should consider whether all the parts are in harmony. You should at least be prepared to address any questions to that effect from the account opening or compliance department. INVESTMENT OBJECTIVES AND RISK PROFILE Your initial discussion with the client must include a review of the client’s investment objectives to determine what plans the client has for his or her money. You can then determine the percentages of funds allocated to safety, income, and growth. Remember that clients may have different objectives associated with different accounts, given that they may have both short- and long-term goals. To determine a client’s risk profile, you must assess both their risk tolerance and risk capacity. Risk tolerance is the willingness to accept risk, whereas risk capacity is the ability to endure loss. It is important for account documentation to specifically address these items. Obviously, you must take into account the time horizon of the investments. You should also ask the following types of questions to determine a client’s risk profile: Given a range of values, what is the highest value you hope for and the lowest you are willing to accept for your portfolio in X years? How would you react to a decline in market value? Would you sell right away, wait a few weeks, wait a year, or hold on for the long term? What portion of your total net worth does this account represent? How much could you afford to lose? © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 17 Remember that you should always evaluate whether a client’s requested investment objective and risk profile makes sense in the context of their overall statement of facts. ACCOUNT INFORMATION Account information consists of the following components: Account type Beneficial ownership Currency Payment/delivery procedures Special instructions ACCOUNT TYPES It is essential that you determine exactly which type of account is suitable for each client. This consideration is of equal importance to the suitability of trading based on investment objectives and account information. There are several considerations as to the suitability of investments for the different account types. Moreover, many accounts are mutually exclusive or have limits regarding certain types of activity. The broad account categories are outlined below, with a brief commentary on each. CASH ACCOUNTS Cash accounts require the client to deposit payment in full for each purchased transaction. For sales, the securities must be in the account or must be delivered to the account by the settlement date of the sale transaction. Cash accounts must be operated in accordance with the industry’ Cash Account Rule, which is discussed in detail further on in this course. Dealer members do not provide financing to clients who operate cash accounts. MARGIN ACCOUNTS Margin accounts require only partial payment for purchases. The dealer member lends the client the unpaid portion of the market value of the securities at prevailing interest rates. The client must make an initial deposit of a specified portion of the value of the securities purchased, which is called the client margin. The client margin varies based on the type of security and its price, and is determined according to a standard formula. Because margin accounts involve a loan by the dealer member to the client, a financing agreement, called a margin agreement, must be completed before the account is approved. Margin accounts are also used for short sales of securities. In such arrangements, with the dealer member’s permission, the client sells securities they do not own. The dealer member borrows the securities and delivers them to the purchaser. The client must leave the proceeds of the sales in the margin account and make an additional margin deposit in case the value of the securities rises. The client then purchases the securities when the client chooses or when the securities can no longer be borrowed, whichever comes first. DELIVERY AGAINST PAYMENT Delivery against payment (DAP) accounts involve the purchase of securities and payment on settlement date. An intermediary, usually a financial institution, often acts as an agent to complete these transactions for the client. The dealer member delivers the securities to the purchaser, or the purchaser’s settlement agent, who then pays for the securities in full. The client (or agent) then has possession of the securities, at which point they do not show in the client’s account. The proposed settlement arrangements in a DAP account must meet the dealer member’s criteria in order for the account to be approved. The client must pay in full before the securities are delivered by the dealer member. Like cash accounts, DAP accounts are subject to the Cash Account Rule. © CANADIAN SECURITIES INSTITUTE 5 18 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 RECEIPT AGAINST PAYMENT Receipt against payment (RAP) accounts, operate as described above for DAP accounts, except that securities are sold by the client. The dealer member receives the securities from the client (or agent) and pays the client (or agent) in full. DID YOU KNOW? DAP and RAP transactions are the norm for institutional accounts. They are often combined in one account, which is usually known as a cash-on-delivery account. REGISTERED ACCOUNTS These accounts are registered in an individual’s name with the Canada Revenue Agency (CRA) as tax-deferral plans. This category includes RRSPs, RRIFs, registered education savings plans (RESPs), tax-free savings accounts (TFSAs), and various locked-in accounts. Rules and regulations governing registered accounts are constantly changing, and detailed coverage is beyond the scope of this course. However, you must be aware of the specific limitations on the types of investments allowed in these accounts. You must also understand the tax consequences related to the flow of monies and securities in and out of these accounts. PRO ACCOUNTS It is a generally accepted industry practice that all employees of a dealer member or a related company and any of their family members living under the same roof are considered to be non-clients. The common name for an account belonging to a non-client is a pro account. INVESTMENT CLUB ACCOUNTS When setting up an investment club account, a specific document, called an Investment Club Agreement, must accompany the standard application. This agreement must contain the names, addresses, and signatures of all of the individual members of the investment club. In addition, one or more of the members of the club must be authorized to give trading and administrative instructions on the club’s behalf. If the registrant handling the account is also a member of the investment club, the account automatically becomes a pro account. Furthermore, the RR cannot be the person responsible for authorizing trades for the account, unless it is set up as a discretionary or managed account. In such cases, the account is made subject to the supervision requirements for accounts of that type. It is very important that the dealer member implement controls over these accounts, such as sending duplicate confirmations and monthly statements to an independent member of the club. DISCRETIONARY ACCOUNTS A discretionary account is one where discretionary authority has not been solicited, but where the client chooses to give it on a temporary basis. In such accounts, the dealer member has authority to select securities and execute orders on the client’s behalf. Clients must clearly indicate their reasons for requesting the discretion, such as in the case of illness or absence from the country. As well, as an RR, you cannot exercise discretionary authority over a client account unless the account is maintained with your employer. Discretionary authority is valid for a maximum term of 12 months. A discretionary account must be specifically authorized, approved, and accepted as such, in writing, by a Designated Supervisor. Both the client and the dealer member must sign a discretionary account agreement, which includes any restrictions to the trading authorization. The dealer member must also have the proper documentation and supervisory procedures in place to handle such accounts. As well, the dealer member must develop and distribute to all approved persons the internal policies and procedures under which discretionary accounts are to be handled. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 19 The following rules apply to discretionary accounts: All discretionary orders must be marked as such at the time of entry. Only persons who have been approved by CIRO to do so may effect trades for a customer in a discretionary account. If the securities of a dealer member or its affiliates are publicly traded, no discretionary account may hold those securities. Registered Representatives who are approved to deal with discretionary accounts must have at least two years of experience in any product that is to be traded on a discretionary basis. For the purpose of this discussion, a discretionary order is any order in which the client has not clearly articulated any one of the following information: the security, the quantity, the price, and the length of time the order is good for (or when the order is entered). A Designated Supervisor must review any discretionary order initiated in a discretionary account by an RR prior to the order being entered, unless the RR has been approved as a Portfolio Manager (PM), or the RR is also an executive and the Designated Supervisor reviews the order no later than one business day after the trade was made. All discretionary orders for client accounts effected by an executive must be reviewed no later than the next day by head office. A Designated Supervisor must also review, at least monthly, the financial performance of all discretionary accounts. To ensure that these accounts are properly supervised, the firm must clearly identify in its books and records which accounts are discretionary. In addition, persons conducting such reviews must have adequate KYC information readily available for each discretionary account. Both the client and dealer member may withdraw from the discretionary agreement, provided that the request is submitted by notice in writing. The client may terminate the agreement at any time. Termination becomes effective when the dealer member receives the notice, except with respect to transactions that were entered into before the notice was received. The dealer member must give the client 30 days’ notice of termination. MANAGED ACCOUNTS A managed account is an account in which investment decisions are made on a continuing basis by the dealer member or by a third party hired by the dealer member. Managed accounts grant discretionary authority on an ongoing basis; in other words, it is a permanent, rather than a temporary, arrangement. CIRO must approve dealer members to handle managed accounts and must be compliant with all the requirements detailed in the IDPC rules. No dealer member or any person acting on its behalf is permitted to exercise discretionary authority over these accounts, unless approved by CIRO as a PM or associate PM. CIRO permits sub-advisors to manage these accounts provided a written sub-advisor agreement with the dealer member is in place. The person or entity acting as a sub-advisor must also be registered to provide discretionary portfolio management services in the appropriate jurisdiction. Furthermore, conflict of interest provisions at least equivalent to CIRO’s rules must be in place. In order for the dealer member to approve a managed account, the client must sign a managed account agreement, and the dealer member’s Designated Supervisor must accept it. The managed account agreement must also clearly indicate the client’s investment objectives for this account. Furthermore, the client must be provided with a copy of the dealer member’s procedures to ensure the fair allocation of investment opportunities among managed accounts. Unlike discretionary accounts, managed accounts may be solicited. Each managed account must be reviewed on a quarterly basis by a Designated Supervisor to ensure that the client’s investment objectives are diligently pursued. Moreover, the managed account must be conducted in accordance with the applicable regulations. Reviews may be conducted on an aggregate basis, where decisions are made centrally and applied across a number of accounts. As with discretionary accounts, both the clients and dealer member may terminate managed account agreements, as long as the request is submitted in writing. Clients may terminate the agreement at any time, but if the dealer member is terminating the agreement, the client must be given at least 30 days’ notice. © CANADIAN SECURITIES INSTITUTE 5 20 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 Managed accounts of partners, directors, officers, and employees or agents of a dealer member are exempt from the client priority rule, where the account is centrally managed with other client accounts and it participates equally with client accounts when investment decisions are implemented. BENEFICIAL OWNERSHIP Obtaining ownership information on offshore accounts can often be difficult. Such accounts might be “veiled” by an offshore jurisdiction’s secrecy laws or unavailable because no multijurisdictional legal assistance agreements exist. In such cases, regulators have begun to apply the KYC rule in its narrowest sense to obtain relevant beneficial ownership information on offshore brokerage accounts. CIRO rules deal with KYC requirements for corporate accounts. The rules outline the circumstances under which the beneficial owners of corporate accounts must be identified. They determine exactly what documentation is required and what procedures should be followed when opening such accounts. These rules are in addition to the requirements specified by FINTRAC in terms of client identification for both individuals and entities. CURRENCY Clients may choose to purchase or sell securities denominated in foreign currencies. Typically, clients request that Canadian dollar transactions remain in Canadian dollars and that U.S. dollar transactions remain in U.S. dollars. However, the evolution to a global market has made available many investments in other currencies. You should check with your operations or credit department to determine in which currencies accounts may be operated at your firm. You must verify that your clients are aware that, in addition to the usual investment risk, an investment denominated in a foreign currency also carries currency risk. Adverse currency fluctuations may not only reduce an investment return but may even result in a loss. PAYMENT AND DELIVERY Methods for payment and delivery of securities traded are fairly standard. When a security is purchased, payment can be taken directly from the client’s account if there is sufficient cash or margin available. Otherwise, the client may deposit sufficient cash to his or her account to pay for the security. These payments must be made within the specified settlement period. Likewise, securities that have been sold must be delivered to the purchaser’s account within a certain time period. Other than in connection with a bona fide DAP account, any request for payment or receipt of funds to a third party is a warning flag, and management should be consulted. Such a request may indicate that a party other than the client has an interest in the account. Many dealer members have specific policies in regard to third-party cheques. SPECIAL INSTRUCTIONS This area of the account application is intended primarily to accommodate special instructions, such as “duplicate confirmations” or “pay dividends monthly”. REGISTRANT INFORMATION This section is so named because the information concerns the RR who is opening the account for a client. Certain information is needed to ensure that the RR is qualified to open the account. LICENSING As an RR, you may occasionally have prospective clients who reside in a Canadian province in which you or your dealer member is not registered. Similarly, you may have existing clients who have moved, or are in the process of moving, to another Canadian jurisdiction. In both cases, you must bring the matter to the attention of the sales supervisor to determine whether orders from this client can still be accepted. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 21 Similarly, a client may reside in, or be moving to, a jurisdiction outside of Canada, in particular the U.S. It is extremely important that these situations be reviewed prior to setting up the account or changing the address. There is less likelihood that you or your firm is licensed to operate in a jurisdiction outside of Canada; most dealer members and RRs are not licensed to do so. And even if you are permitted to carry on securities-related business outside of Canada, there may be legal, income tax, and non-resident tax considerations. SOURCE OF THE CLIENT It is important to know how the client came to you and your firm for several reasons. First, it is a good idea to track referrals. Second, you should treat prospective clients who are “phone-ins” or “walk-ins” with caution, unless they have been referred by someone you know. By no means are all such clients dishonest, but the likelihood of problems may be higher in these cases. If a client does approach you to open an account, you should inquire to determine the reason. DIRECT OR INDIRECT INTEREST There are specific rules about RRs participating with clients in the operation of an account. As an RR, you must limit such participation to those situations where the other party or parties are direct family members. In such cases, you should fully disclose your interest on the account application. In the case of discretionary accounts, orders should be marked “pro” only if the RR has some type of beneficial interest in the account. REGULATORY SECTION Regulatory issues of particular importance in the account opening process are those related to company ownership and undisclosed interest, trading authorization, and power of attorney, among others. INSIDERS AND CONTROL PERSONS With all accounts, you must determine whether your client is an insider or control person of a publicly trading company. If a person owns more than a certain percentage of a class of voting or equity shares of an issuer (usually 10%), then that person is generally considered to be an insider. A control person is a person who generally owns more than 20% of an issuer’s equity and therefore has significant influence over that company. INSIDERS Insiders are likely to be board members or part of the company’s management, and are also likely to possess inside information from time to time. Persons who have inside information may not engage in the following activities: Purchase or sell securities of the issuer about which they have inside information. Pass the inside information along to someone else. Induce someone else to trade in the issuer’s securities. Insiders may trade when they are not in possession of inside information, but they must file reports with the securities commissions detailing their trading. Insiders must report their trades within 10 days after the date of the trade. You should remind your clients of their obligation to file insider reports. Of course, as the RR, if you become aware of inside information through a client, you must not use it for your own personal gain, nor should you pass the information on to anyone else. To do so is to engage in tipping, which is illegal. CONTROL PERSONS Often, the question of whether a person has a controlling interest must be legally determined. However, the status of a potential control person must be established before that person trades in the securities of the company in © CANADIAN SECURITIES INSTITUTE 5 22 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 question. Control persons typically may not sell their company’s securities, unless they file a prospectus or other disclosure documents with the securities commission and stock exchange where the securities trade. Purchases by control persons must be carefully scrutinized to ensure they do not constitute a take-over bid. As an RR, you must identify potential insiders and control persons, and escalate questions concerning their trades to your supervisor or compliance officer. When opening an account, you should ask whether anyone other than the client has any financial interest in the account. If the answer is yes, you must obtain additional information on all parties and an explanation as to why it is not disclosed in the name of the account. Under no circumstances should you open such an account or enter into any transactions without discussing it with senior management and getting their approval. TRADING AUTHORIZATION AND POWER OF ATTORNEY If anyone other than the account holder has authority to trade for the account, you must determine exactly what authority has been delegated. Is it limited to the entering of orders, or is it broader and inclusive of payments of monies and deliveries of securities? There is often a standard trading authority form to accommodate one person appointing another person to act on their behalf. However, such authority is usually limited to the entering of orders. A general power of attorney is typically required if the authority delegated is broader. Signatures for all authorized individuals are required. You must always keep in mind that your responsibilities are to the account holder and not to any other person with trading authority. Investment objectives and risk factors for each investment must still be appropriate for the client. Similarly, if you have any concern about a proposed activity, such as issuing a cheque from the account payable to someone other than the client, you should discuss it with management before you carry out the instructions. You should also ask whether the account is either a discretionary or managed account. If it is either, you must be approved as a PM or be otherwise permitted to exercise discretion. Those RRs who are qualified as PMs must open managed accounts in accordance with relevant specific policies. You must not solicit discretionary authority. If you receive an unsolicited request for a discretionary account, and are qualified to handle such accounts, you must obtain management’s approval before opening the account. No unauthorized discretionary trading is permitted. POWER OF ATTORNEY Whether by encouraging investors to provide alternate contact information or to execute a power of attorney, preparing for the future is an increasingly important issue. Because a power of attorney can be abused, dealer members should develop practices to address risks associated with them. The following processes can be implemented to reduce such risks: Identify accounts where a power of attorney is added or changed and where subsequent activity does not align with the investor’s stated ﬁnancial objectives and proﬁle. For example, look for evidence of unusual cheques written out of the account within a given time frame, or a concentration of cheques to a single third-party payee. Require that copies of all conﬁrmations and account statements be sent to both the account holder and the power of attorney. Check the investor’s signature against other signed documents received to determine authenticity. BANKING INFORMATION Banking information can be used to assist in the verification of a person’s identification under the PCMLTFA. The credit department may also wish to check banking information if there are concerns about a new client being a credit risk. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 23 CLIENT ACKNOWLEDGEMENT All documentation must be positively acknowledged by the client at the time of the account opening. The client’s signature is preferred. However, where a signature cannot be obtained, other forms of acknowledgement that the client received the documentation are acceptable. They may include a documented phone conversation or an email from the client. DISCLOSURES 4 | Understand account disclosure requirements, including the Relationship Disclosure Document. Disclosure and transparency are increasingly important aspects of the account opening process in the current regulatory environment. The various disclosure requirements in this respect are described below. RELATIONSHIP DISCLOSURE Dealer members must provide all retail clients with a Relationship Disclosure Document that outlines the account relationship and services to be provided to the client. The Relationship Disclosure Document must include a description of, or information relating, to the following aspects of the account: The types of products and services the firm offers. The account relationship to which the client has consented. The process the firm uses to assess the client’s KYC information and investment suitability. When account suitability will be routinely reviewed. Whether suitability will be reviewed in other situations, including market fluctuations. Material firm and adviser conflicts of interest. A statement that future material conflict of interest situations, where not resolved, will be disclosed to the client as they arise. All fees and charges associated with operating, transacting, and holding investments in the account. Complaint handling procedures. Clients must also be provided with CIRO’s brochures explaining how to make a complaint. The reporting the client will receive, including when account statements and trade confirmations will be sent and a description of the firm’s obligations to provide performance information, including whether or not percentage return information will be sent. DISCLOSING CONFLICTS OF INTEREST A dealer member must provide disclosure to clients who may be impacted a particular material conflict of interest at the time of account opening or in a timely manner if the conflict is identified at a later point in time. For each conflict identified, the disclosure provided to clients must be prominent, specific, and written in plain language. It must disclose the following matters: The nature and extent of the conflict in question The impact and risk it may pose to the client The way in which it has been or will be addressed © CANADIAN SECURITIES INSTITUTE 5 24 CONDUCT AND PRACTICES HANDBOOK COURSE SECTION 2 Unless a material conflict of interest has been avoided, it must be disclosed to the client in all cases where they would expect to be informed. The disclosure should not be generic, incomplete, or misleading, and it should not be obscured behind excessive details or minuscule font. Disclosure may not be appropriate if a conflict of interest involves confidential or commercially sensitive information or if the information amounts to inside information under insider trading provisions in securities legislation. In these situations, registered firms must assess whether there are other methods to adequately address the conflict of interest. If not, the firm may have to withhold the service to avoid the conflict. Dealer members should also have specific procedures for responding to conflicts of interest that involve inside information and for complying with insider trading provisions. PRE-TRADE DISCLOSURE OF CHARGES Before a dealer member accepts instructions to purchase or sell a security in a retail account other than a managed account, it must disclose the charges the client will be required to pay. In the case of a purchase to which deferred sales charges apply, it must disclose that the client may be required to pay a deferred sales charge on the subsequent resale. It must also disclose whether the firm will receive trailing commissions in respect of the security. This disclosure is not required for institutional customers. It is also not required with clients for whom the dealer member purchases or sells securities only as directed by an RR acting for the client. DISCLOSURE WHEN ACTING AS A PRINCIPAL Dealer members intending to trade as a principal in securities transactions with non-registrants must disclose this information in their communications and on every trade confirmation. Communications include circulars, pamphlets, letters, telegrams, or advertisements. Such statements do not prevent a firm that acts as a principal from subsequently acting as an agent in the trading of such a security. If a firm does not disclose its principal status, the client who either bought or sold the security may rescind the contract. (In the case of a purchase, the security must still be in the client’s possession.) A dealer member that publishes written materials containing a security recommendation must disclose its relationship with the issuer. Specifically, it must disclose whether the firm or any of its officers or directors has, within the past 12 months, assumed an underwriting liability for the issuer, or provided financial advice or consideration to the issuer. The firm, along with its officers and directors, must also disclose whether they will receive any fees as a result of that recommendation. DISCLOSURE RELATING TO PRODUCTS Similar to the requirement to provide the purchaser of a new issue with a prospectus, certain products require additional disclosure to clients. As an RR, you are obliged to know your responsibilities in this regard before dealing in the following products: Initial public offerings Investors in newly issued securities must be given a prospectus. The prospectus provides (IPOs) a detailed description of the securities offered and of the issuing corporation, including its history, operations, and audited financial statements. You must have a fundamental understanding of the content of the prospectus and also to understand why it is imperative that all purchasers of new securities receive it. Mutual funds Purchasers must receive a Fund Facts document prior to purchase. Some issuers provide one document that covers their entire family of funds. The prospectus for a mutual fund must also be available to investors upon request. © CANADIAN SECURITIES INSTITUTE CHAPTER 5 CLIENT DISCOVERY AND ACCOUNT OPENING 5 25 Strip bonds and strip All first-time buyers of strip bonds and strip coupons must be given an information coupons document outlining the special investment characteristics of these securities, including: Price volatility Income tax consequences Extent of a secondary market Custodial arrangements of strip bonds and coupons The above disclosures must be made before entering t

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